Pound Rallies vs. Dollar As US Fed Hike Rates, Eyes Turn To BoE

TransferWise content team

14.12.17

3 minute read

The pound soared against the dollar on Wednesday, boosted by UK wage data and on concerns over weak US inflation. The pound US dollar exchange rate charged above US$1.34 for the pound, a level not seen since Monday.

What do these figures mean?

When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written: 1 GBP = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the US dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

The pound was in demand in the previous session, after data released by the Office of National Statistics showed that average wages in the UK were increasing. In the 3 months to October the average hourly wage increased 2.5%, an improvement on September’s 2.3%. Interestingly the unemployment rate stayed steady at 4.3%, the lowest rate since 1975, rather than ticking lower as analysts had forecast. This could be evidence that the UK is reaching full employment, which would encourage wages to rise further going forward. Should this be the case, wages could continue to close the gap on inflation, which was at 3% in October.

Today investors will towards Bank of England’s (BoE) interest rate decision. The central bank is expected to keep interest rates on hold after hiking them just last month. Market participants will be listening closely to BoE Governor Mark Carney’s outlook for the coming year. Investors are going to keep an eye on his view on the path for inflation and Brexit deal. Should Carney sound conservative over his assessment for the coming year, sterling could fall.

Fed Hikes Rates By 0.25%

As both analysts and investors expected, the US Federal Reserve monetary policy committee raised interest rates on Wednesday, by 0.25%, in a 7 – 2 vote. The 2 dissenters represent the Fed’s concern over soft inflation despite a strong labour market and robust economy. Fed Chair Yellen acknowledged the weak inflation and said that the Fed would continue monitor it closely next year. Inflation data earlier on Wednesday showed that core consumer inflation softened in November, after the biggest drop in clothing prices in nearly two decades. Investors fear that this could slow the rate at which the Fed will hike rates next year.

Why do raised interest rates boost a currency’s value?

Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.

In the policy meeting the Fed increased their growth forecasts for 2018. However, the central bank didn’t go as far as to increase the future path of interest rate rises. The Fed is still expecting to raise rates three times through the course of 2018. Investors are more uncertain whether the Fed will achieve this, which is why the dollar dropped.

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